Geithner's Plan Ignores Mark-to-Market: Where's the Beef?

Treasury Secretary Geithner did no one any favors Tuesday when he served up an all-bun bank-stabilization plan; it lacks essential details and sufficient scope. Judging from the market’s reaction, it won’t likely have the effect that Geithner intends. Thus did the administration waste an opportunity to improve market confidence. And Geithner’s presentation skills make Henry Paulson’s look smooth by comparison. Is Geithner enough of a politician to be a successful Treasury Secretary?

Clearly, much of the “plan” has yet to gel. With regard to the private-public fund, for instance, no analysis is possible. Stress testing banks that seek additional public assistance isn’t a plan, it’s a technique--and not a very reliable one, at that. There’s no aggregator bank, or asset-guarantee program either. Where, indeed, is the beef?

Worse, if any imaginative thinking is going on at the Treasury, it must have been smothered. Why, for instance, no mention of mark-to-market accounting for illiquid and hard-to-value investments? As I’ve argued here before, pricing issues are the centerpiece of the whole debate. The original TARP and now the aggregator good / bad bank stumbled on the issue. A consensus has developed that FAS 157 results in unrealistic valuations, even as it creates very real capital adequacy and solvency problems in banks, insurers, and others.

For example, the Bank of New York Mellon (BK) reported that in the fourth quarter, it wrote down its $5 billion investment portfolio of Alt-A residential MBS by $1.4 billion, or about 25%. If the bank had accounted for the securities as loans, it estimates these same assets would have been impaired only $208 million, just 4% of the portfolio’s face value. The difference between the two accounting treatments: more than $1 billion.

One Alt-A MBS expert, Thomas Patrick, chairman of New Vernon Capital and a former Merrill Lynch vice chairman, calls mark-to-market accounting a “swamp” in this environment, an “accounting fiction” better reflecting the “financial desperation of sellers than the value of the securities sold.”

In 3,700 mortgage securitizations he examined, Patrick found that of $1.4 trillion in Alt-A mortgages, $948 billion were current on interest and principal, while $452 billion were delinquent more than 30 days. Further, banks carried the performing mortgages at an average 50% of par. Patrick observes that if owned directly as loans, the banks would carry the mortgages closer to par. He concludes that the mark-to-market fiction has created enormous financial difficulties.

Patrick proposes that these securities be dismantled. Banks would be allowed to rebook performing mortgages as loans at par less appropriate reserves. Accounting gains would absorb remaining losses in the non-performing mortgages.

Similarly, Dutch banking authorities evaluated a $39 billion portfolio of Alt-A MBS owned by ING and marked-to-market at 65% of par. They subjected the cash flows of the 600,000 loans comprising the securities to severe stresses (principal assumptions were another 10% decline in home prices, and a 50% decline from peak prices in Florida and California) and concluded that the bonds were likely to return 90% of their original value.

There are many causes of the current troubles, but the solution set has to include changes in the absurd mark-to-market accounting rules. So far, we’ve seen few fully formed solutions coming from the new administration, while creative and imaginative private sector approaches fall on deaf ears.

Comments

[Moon Kil Woong:]

The problem with these assessments is it takes into account the current state of these baskets of mortgages and not the future default rate. We exist in a recession that is getting worse. With that fact, inevitably these mortgage basket will erode further. Further compounding this situation is the fact that people worry the government may have to step in and force re-working of the terms. And of course, sales of similar mortgages would necessarily cause an accounting event further eroding the market value of these securities as they wait for them to mature.

That is why no one wishes to buy them. Can you blame them? Especially since the government is indicating they will offer all sorts of perks and cover some of the losses. Thus expectation of government giveaways destroys the current marketability of these securities. And threats of government foreclosure laws and contracts also destroys the very loan market they are trying to save.

Thus, once again, the governments actions create unintended consequences that actually hurt the very thing they are designed to help, while their loan guarantees for some securities are used to the advantage of the former executives of Countrywide to rip off the American people once again.

If there was real fair value to maturity close to break-even with no real downside risk someone would be buying them at 40-60% discounts to face value. The fact there isn't shows either they are waiting in expectation of better values because of government giveaways or there really isn't such implied value without inordinate amounts of risk that some people are claiming that there is.

I don't buy the last argument that there just isn't enough liquidity in the market to let people willing to buy these at a fairer value can't get the credit. It is no longer plausible. Liquidity isn't the problem, value is the problem.

Feb 12 05:19 AM

[da'zman:]

I don't know the methodology of the Dutch authorities but much depends on which tranche they own as convexity increases substantial as you go from one slice to another. Another thing not being mentioned much is extension risk. Clearly a security priced at par with an expected maturity of 3 years or so has a different value if it then becomes a 30 year security. In the end, you cannot directly compare a securitization to a standalone mortgage loan.

Feb 12 06:47 AM

[Pj568:]

Let's see. If these securities are loans on houses and home values have fallen by 40% with additional decreases expected, loan to values negative, individuals are overextended with no credit available and unemployment estimated to hit 9 or 10 percent, why again are the mark to market values not realistic? Is it only because another counting method yields a higher number? Maybe arguing for an accounting change in the other direction is more realistic?

Feb 12 09:49 AM

[J. D. Swampfox:]

If we suspend Mark to Market because it is inaccurate/unrealistic... then the market has been fooled for all this time about the risk and there really is no problem at all? Why don't we just suspend ALL financial statement preparation and publication of ANY sort? That should make stocks really go up -right?

Feb 12 10:12 AM

[BDHPlayer:]

Am I wrong in believing that a big part of the mark to market problems is potential returns that buyers want. For example, a buyer won't buy unless he can get a projected return of 20% per year. The bank or brokerage firm that owns the asset wants a 8% return. Bingo, there is a big difference between the bid by the hedge fund and the offer by the bank.

Feb 12 10:23 AM

[kelm:]

This is interesting. If I understand you correctly there is a distortion in the value of the assets because they have been securitized. As securitized assets the mark-to-market is under different reporting standards then if they were a collection of loans owned outright. If I have got that correct this is huge and something I have heard no one else discuss. The answer then would indeed be to break the securitized instruments up so banks go back to owning the loans (or crap) that they created in the first place and valuing those according to standard accounting practices. This would actually enhance transparency as it would eliminate the opacity caused by the securitization.

Feb 12 10:27 AM

[monday1929:]

I hope Geithner doesn't read this. He'll think it's a GREAT idea.


On Feb 12 10:12 AM Jon D. Pratt wrote:

> If we suspend Mark to Market because it is inaccurate/unrealistic...
> then the market has been fooled for all this time about the risk
> and there really is no problem at all? Why don't we just suspend
> ALL financial statement preparation and publication of ANY sort?
> That should make stocks really go up -right?

Feb 12 11:22 AM

[monday1929:]

The LAST thing they really want is transparency. That would result in jail time.


On Feb 12 10:27 AM kelm wrote:

> This is interesting. If I understand you correctly there is a distortion
> in the value of the assets because they have been securitized. As
> securitized assets the mark-to-market is under different reporting
> standards then if they were a collection of loans owned outright.
> If I have got that correct this is huge and something I have heard
> no one else discuss. The answer then would indeed be to break the
> securitized instruments up so banks go back to owning the loans (or
> crap) that they created in the first place and valuing those according
> to standard accounting practices. This would actually enhance transparency
> as it would eliminate the opacity caused by the securitization.

Feb 12 11:24 AM

[pearl2k:]

If you break the securitized instrument does that really mean you own the mortgages?


On Feb 12 10:27 AM kelm wrote:

> This is interesting. If I understand you correctly there is a distortion
> in the value of the assets because they have been securitized. As
> securitized assets the mark-to-market is under different reporting
> standards then if they were a collection of loans owned outright.
> If I have got that correct this is huge and something I have heard
> no one else discuss. The answer then would indeed be to break the
> securitized instruments up so banks go back to owning the loans (or
> crap) that they created in the first place and valuing those according
> to standard accounting practices. This would actually enhance transparency
> as it would eliminate the opacity caused by the securitization.

Feb 12 01:00 PM

[Moon Kil Woong:]

kelm: there is a few problems with breaking up packaged mortgages. 1) no one has the authority to break them up. 2) they are probably tied and insured by CDS or other derivatives securities and 3) even if you break them up the real negative value still remains. In fact the more transparent they get the worse value they are turning out to be. Thus, I doubt if suspending market to market will make them more valuable. In fact, it would probably make them close to worthless.

Feb 13 01:56 AM

[Paul_L:]

Geithner wiggled out of many questions and he got away with them as usual. It is disappointing to see at this time of great crisis he was the CHOSEN one with one year immersed in the core issues. It is more a Closet smooth Do Right Geithner. Hope market won't drop another 15% after his talk. Mark to market should be modified with holding period and expected defaults to come to a compromise to alleviate the intense, immediate and escalating capital requirements. It will give more time for the economy and market to adjust. Mark to market gives no one any time. A house dropped 60% in Florida, Arizona, California is causing all houses to drop 60% or less, would you agree? AICP, SEC, rating agencies and so forth are also responsible for this crisis.

Mar 04 03:56 PM